Fed Flummoxes Traders in The Mortgage Market

By Liz Rappaport

Reuters

New York Fed chief William Dudley

There are no secrets in the bond markets. The New York Fed should know that.

A couple of hours Thursday afternoon in the markets for riskier mortgage-backed bonds show how hard it is for the Fed to be a player in sophisticated credit markets where information travels speedily and traders are skillful in finding an edge.

Thursday afternoon, the New York Fed tried to keep hush hush Goldman Sachs Group Inc.’s offer to buy a multibillion dollar parcel of risky mortgage bonds from its Maiden Lane II portfolio. But when word got out that the Fed had canvassed a few other dealers for competing bids, the news traveled fast that the U.S. central bank was back in the market with some of the toxic mortgage bonds it had acquired from the 2008 rescue of American International Group Inc.

The AIG portfolio sale was important to traders because they learn from mistakes. The last time the Fed tried to unload some of its crisis-era holdings, auctions it held last year wound up driving down prices of mortgage bonds. The Fed backed off and halted the auctions. Traders didn’t want to be caught off-guard by a downtick in the prices of the securities they have for sale caused by the Fed’s unloading.

Traders blasted Bloomberg messages and emails to each other wondering what was going on, how the Fed’s sudden sale would impact the market, and sending cut-and-pasted copies of the Dow Jones story to each other, said traders.

But it was also bewildering for another reason and it caused trading to briefly grind to a halt.

Maybe 10 minutes prior, many traders received a list of mortgage bonds available for sale by the Federal Reserve, but not from the Maiden Lane II portfolio, but rather from its Maiden Lane LLC portfolio – the Bear Stearns rescue assets, not the AIG rescue assets. The sizes of the two sales also confused traders. The notional size of the Maiden Lane I bid list was $6.7 billion – awfully close to the $7 billion Maiden Lane II bonds up for sale.

Some wondered if the Dow Jones story was wrong, or if the Fed’s left hand knew what the right was doing.

Turns out the story was true and the Maiden Lane I sale was real. Once the market figured it all out, the afternoon had passed and trading hours were over.

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